The method of price calculation in transactions between related entities
One of the most important elements of transactions between related entities is the determination of the price calculation method. The very method of calculating the price in a transaction with a related entity must be clear for the controlling party and easy to apply in practice.
A significant limitation of the freedom of action of the tax authorities is the inability to freely estimate income in the event of establishing the existence and use of relations between entities. Estimation can be done using the following methods:
comparable uncontrolled price,
a reasonable margin ("cost plus").
In the event of an inspection, officials must follow the regulations of the Regulation of the Minister of Finance of September 10, 2009 on the method and procedure for determining the income of legal persons by way of estimating and the method and procedure for eliminating double taxation of legal persons in the event of an adjustment of profits of related entities (Journal of Laws No. 160, item 1268) 5, and in particular - with the methods of price estimation defined in this regulation. Since the aforementioned legal act is addressed to the inspectors, it is worth knowing the adopted method. This will help avoid misunderstandings and facilitate mutual understanding between the taxpayer and the tax authorities.
If the application of the above-mentioned methods is not possible, the tax office should apply the transaction profit methods.
The comparable uncontrolled price method
It consists in comparing the price determined in transactions between related entities with the price used in comparable transactions by independent entities and on this basis determining the market value of the subject of the transaction concluded between related entities.
Transactions with unrelated parties that are the basis for the comparison should:
concern products, services or other benefits of the same type,
concern transactions of comparable value,
be concluded at the same stage of the distribution chain and
be concluded on similar terms as the valued transactions with related entities.
This method may take the form of:
internal price comparison - it is assumed that related enterprises sell the same good or provide the same service under comparable conditions to a related entity and to an independent entity, or purchases the same good or service from a related and independent entity. In such a case, the price used in trade with independent enterprises is also the reference point in the research applied to related entities.
external price comparison - consists in comparing the price applied to related entities with a price agreed between unrelated companies of the same industry in the turnover of the same goods or services.
In cases where it is possible to apply the comparable uncontrolled price method, it is applied first, unless the use of another method allows to set prices in transactions at a level closer to the market value of the subject of such transaction and allows for a more precise determination of the taxpayer's income.
The price calculation method and the resale price method
It consists in reducing the price specified in the transaction of a given entity with an independent entity regarding goods or services previously purchased by a given entity from an entity related to it, by a resale price margin. The price determined in this way may be considered the market price in transactions of a given entity with an entity related to it.
The resale margin should cover the entity's direct and indirect expenses related to the transaction. The margin should be calculated in such a way as to adequately compensate for the risks, functions and assets involved. It should ensure a profit rate appropriate for this type of transaction, determined taking into account the scope of functions performed by individual entities participating in a given transaction.
The resale price margin does not include the expenses equal to the price of the subject of the transaction and general and administrative expenses, i.e. the entity's operating costs.
At the same time, the resale price margin is determined by reference to the level of the margin that the same entity uses in comparable transactions with independent entities or the margin in comparable transactions by related entities.
When determining the resale price margin, the following are in particular taken into account:
factors related to the passage of time between the original purchase and resale, including changes in the market in terms of costs, exchange rates, inflation,
changes in the condition and degree of wear of things or rights that are the subject of the transaction, including those resulting from technical progress in a given field,
the reseller's exclusive right to sell certain things or rights that may affect the decision to change the margin.
Reasonable margin method ("cost plus")
This method consists in setting the selling price at a level corresponding to the sum of costs directly related to the purchase from an independent entity or the internal production of the objects of the transaction and the appropriate profit resulting from market conditions and functions performed by the parties to the transaction, as well as indirect costs, excluding general and administrative costs. is the operating cost of the unit as a whole and the cost of managing that unit.
The margin is determined by referring to the level of the margin applied by the entity in transactions comparable with independent entities, or by comparing the margin applied in comparable transactions by independent entities.
The method of price calculation and the method of transaction profit
When it is not possible to determine the income using the methods set out above, the transaction profit methods are used, which consist in determining the income on the basis of the profit that could reasonably be expected by a given entity participating in the transaction.
The regulations allow for the use of the following two methods of transaction profit:
a. Profit sharing method
It consists in determining the appropriate profit distribution between related entities obtained from the sale of goods or services to subsidiaries and previously produced jointly by related enterprises in accordance with the principles of profit distribution that would be established by independent entities in mutual relations. In other words, it consists in determining the total profits generated by independent entities in connection with a given transaction.
Determining the distribution of profits that independent entities would expect from participation in the transaction is made using one of two methods:
residual analysis, which divides the sum of profits obtained in connection with a given transaction (s) by related entities participating in this transaction (s) in two stages; in the first stage, each transaction participant is assigned the minimum profit achieved by independent entities in this type of transactions; in the second stage, any profits remaining after the distribution in the first stage are divided among related entities participating in a given transaction in accordance with the rules that would be established by independent entities participating in such a transaction; if the sum of profits achieved by related parties is lower than the sum of the profits assigned in the first stage, the profits assigned are reduced; the adjustment made in the second stage takes into account the economic functions performed by the parties
Interest analysis that shares the combined profit between related parties on a transaction in goods produced or improved by those parties, based on the relative value of the actions taken by each related party, taking into account the economic functions performed by the parties.
b. the net transaction margin method
The net transaction margin method consists in examining the net profit margin obtained by the entity in transactions or transactions with another related entity and determining it at the level of the margin obtained by the same entity in transactions with independent entities or the margin obtained in comparable transactions by entities independent.
This margin is calculated by deducting from the income the costs incurred to achieve the revenues, including general management costs.
The methods described above are mandatory for the tax authorities. The provisions of the CIT Act prefer traditional methods over transaction profit methods. Therefore, when selecting a method for the transaction valuation, tax authorities should analyze the following methods one by one and proceed to the next one only if the previous one cannot be applied.